Founded in Halifax, Nova Scotia in 1864, Royal Bank of Canada (RY) has grown into Canada's largest financial institution, and the 14th largest bank in the world by market cap. Royal Bank (which I will refer to as RBC) is a diversified financial services company, boasting significant insurance, wealth management, mutual fund, capital market, and foreign subsidiaries.
Over the past 4 years, the company has grown earnings nicely:
2009 - $3.85
2010 - $3.78
2011 - $4.55
2012 - $4.96
After a stagnant growth during the financial crisis, the bank has continued increasing their dividend:
2009 - $2.00
2010 - $2.00
2011 - $2.08
2012 - $2.28
2013 - $2.49*
The company increased their quarterly dividend early in the year, increasing it from $0.60 to $0.63 a share. The current payout ratio is approximately 50%.
Like any bank, RBC is largely dependent on mortgage growth. The Canadian real estate market has been on a tear for the last decade, even powering through a dip during the tumultuous 2008-09 period. RBC grew their Canadian mortgage book to $195B in 2012, up a little over 5% compared to 2011.
The Canadian real estate market has been somewhat softer in 2013, but prices are holding steady. There is increasing speculation Canada's real estate market is poised for a fall, which would undoubtedly hurt RBC. Current mortgage arrears are 0.33% for Canada as a whole, a reasonable proxy for RBC, since they're the country's largest lender. Arrears peaked at a little over 1% during the high interest rates of the early 1980s, but Canada's previous real estate bubbles have been more regional in nature. Toronto declined sharply during the early 1990s, while the weakness during the 1980s was more focused in the western markets of Calgary, Edmonton and Vancouver.
Approximately 65% of RBC's mortgages are insured by national mortgage insurer CMHC. This insurance, paid by the borrower, protects the bank in case the borrower cannot repay their mortgage during a default. (One reason defaults are so low in Canada is because most borrowers have significant equity, and they just sell if they hit hard times.) CMHC only covers the amount owing, the bank is still responsible for the costs associated with disposing of the property, foreclosure costs, and so on. Even if a mortgage is insured by CMHC, the bank will most likely incur some out of pocket costs. Thus, even insured mortgages still carry some risk for RBC.
The other main growth driver for RBC has been their personal loans division, which includes lines of credit (both secured and unsecured) and vehicle loans. Personal loans have risen 8% year over year, largely fueled by home equity lines of credit. Again, RBC's recent growth is strongly correlated to the growth in Canadian housing.
The bottom line is RBC will be adversely affected if there is a large scale housing correction in Canada. Default rates will go up and loan growth will slow dramatically.
Let's take a look at some other divisions of the bank. Wealth management revenues were up slightly, increasing from $4.71B to $4.85B year over year. Assets under management went up as well, mostly due to rising equity markets. As long as markets continue to go higher, this should be a steady business for the bank.
RBC's insurance business continues to steadily perform, as 2012 revenues rose 10% compared to 2011. Net income increased as well, up 19% to $119M, thanks to decreased claims.
RBC's capital markets division continued to grow earnings, increasing net income from 2011's $1.29B to $1.58B. Capital markets is RBC's second largest division after lending, but could see weakness in the future. Many of Canada's IPOs over the past couple years have been resource companies, growth which will taper off with the overall weakness in the precious metals market. Europe may also continue to be weak in the near term.
Like any bank, RBC regularly performs stress tests, and is both Basel II and III compliant. Tier 1 capital ratios are solid as well, checking in at 13.1%. One note is that Standard and Poors recently cut the debt ratings of every major Canadian bank to AA negative, citing increased housing prices and consumer debt levels.
As I mentioned above, the greatest risk for RBC is a slowdown in the Canadian real estate market. Even if the real estate market doesn't see significant price declines, a slowing of mortgage originations will hurt the stock. The stock is barely trading at a 10x P/E, so I think the market has already priced this risk in.
RBC has delivered solid results over the past few years. Even if there is a slowdown in their loan business, the dividend is safe, and RBC is a solidly ran bank. If you're looking to hold a Canadian bank, RBC is a pretty good bet.